Can we also exempt teacher retirement from tax? And, other questions about the Governor’s tax plan.
by David Ferguson
A friend who is a teacher asked me: “Can Arkansas exempt teacher retirement pay from the state income tax like they are going to do for military retirees?” She had read about Governor Hutchinson’s plan to exempt all military retirement pay from state income tax. She thought also exempting teacher retirement pay would be a good way to encourage teachers to stay in the profession and offset low teacher salaries.
She didn’t like the answer: “No. It is not possible to give a similar tax break to retired Arkansas teachers.”
I realized there is a lot the public doesn’t understand about the tax plan, and few remember Arkansas’ past history of giving income tax breaks to certain groups. I will answer her question here, and also try to fill you in on some details you probably don’t know.
Before beginning, I want to make sure you know Conduit for Action is on records as being in favor of the tax exemption for military retirement, if tax increases are taken out of the bill.
I wish we could have real tax reform for all Arkansans, but I am not opposed to it either if the increase in taxes are taken out.
Some of this information may be of more interest to you than other parts, so here is a list of the questions I will cover so you can skip down and read the parts that interest you most:
- Why can’t we give a similar tax break to other groups?
- What is the law on retirement pay taxation in Arkansas?
- Will all veterans get the proposed tax exemption?
- Will the tax exemption encourage retired military to move to Arkansas?
- Couldn’t we fund the military retirement exemption with budget cuts?
- Why can’t we give a similar tax break to other groups?
Exempting military retirement income is a special case. Arkansas can’t have a special carve out for retirement for other groups in the state, such as teachers, without doing it for all federal civil service retirees and that would be a huge cost.
Arkansas used to exempt all teacher retirement pay from the state income tax. The teacher retirement pay exemption was repealed because of the impact of a decision by the United States Supreme Court. The 1989 decision involving the state of Michigan said such carve outs for state groups discriminate against federal employees and are not allowed.[i]
Shortly after the Supreme Court decision, some retired federal civil service employees announced they would sue Arkansas if they were not given the same full exemption for their retirement pay that Arkansas teachers got.
Later the same year, the Arkansas General Assembly was called into special session by Governor Bill Clinton to repeal the special tax exemption for teachers. Under Act 27 of the Third Special Session of 1989, teacher retirement pay began being treated the same as any other type of retirement pay.
In a later case the United States Supreme court said a state couldn’t provide a special exemption unless it provided it for military retirees.[ii]
How can Arkansas give special treatment to military retirement pay but not for teachers? A special exemption for military retirement pay does not violate the court decisions, and therefore the legislature is not prohibited from providing the exemption.
So, if you have been thinking teachers, law enforcement officers, firefighters, etc. might be able to ride the coat tails of retired military to get the same exemption, think again.
- What is the law on retirement pay taxation in Arkansas?
If you are receiving retirement pay, Arkansas exempts the first $6,000 of your retirement pay from the Arkansas income tax. The $6,000 exemption applies to both public and private retirement. Currently all retirees are being treated the same. When the full teacher retirement exemption was repealed in 1989 this is what replaced it.
The $6,000 retirement pay exemption has never been adjusted for inflation, so the exemption only has about half the buying power it did in 1989. According to the federal Bureau of Labor Statistics, today it would take $11,613.24 to equal the buying power the exemption had in 1989.
The problem with trying to adjust the exemption for inflation is it would cost a lot of state money. The state is not willing to take on that much in budget cuts.
- Will all veterans get the proposed tax exemption?
Most veterans will not get a benefit from the tax exemption. It only exempts military retirement pay, which means you had enough years of military service to qualify for retirement. A veteran may have combat tours but still will not qualify if he or she didn’t or couldn’t stay in long enough to retire.
Some veterans (those with military retirement) will see a benefit. The rest of the veterans only get tax increases. This issue would go away if the tax increases were removed from the plan.
I can’t help but think of a friend who only lacked a couple of years to qualify for military retirement, but who chose to separate from service because he was about to be sent overseas again, and he thought it would put him at risk for losing custody of his children. I would like to honor veterans like him, too, but under the current plan people like him only get higher taxes.
- Will the tax exemption encourage retired military to move to Arkansas?
It has been said that the tax exemption for veterans who get military retirement, will encourage retired military to move to Arkansas. I think it is good policy to try to attract retired military to Arkansas. The question is: Will this exemption really do that?
I don’t have the answer, but there are several states with income tax exemptions for military retirement. They should be able to tell us whether their tax exemption had any impact on the number of military retirees moving to their states.
One of the disadvantages Arkansas has in attracting military retirees is two of our neighboring states have NO income tax. If a veteran moves to Texas or Tennessee not only will the veteran’s military retirement not be taxed but there is no tax on the income they make from a second career.
Without more information from other states, it is hard to tell what impact the exemption would have on getting retired military to move to Arkansas.
- Couldn’t we fund the military retirement exemption with budget cuts?
The tax exemption for veterans with military retirement is said to cost about $13 million a year.[iii] Compared to the $5.48 Billion state budget being proposed, $13 million seems like a drop in the bucket.[iv]
Yes, the tax cut could be funded with budget cuts. Cutting the state budget instead of raising taxes seems attractive to me, especially after reading articles in the newspaper about the wasting of hundreds of millions of dollars.
Here is the challenge with trying to fund it with budget cuts. Politicians across the country don’t like budget cuts. Budget cuts are hard. The tendency of politicians accross the country is NOT to cut the programs with the most waste or least benefit, but to pick programs that will HURT THE MOST if cut. The purpose of choosing painful cuts is to put public pressure on other politicians to drop the idea of budget cuts.
The other problem is the state budget process does not include a meaningful review of the benefit or success of state programs. Instead most agencies slide by with an across the board yearly increase.
Even though funding the tax exemption for military retirement with budget cuts seems to be a better decision in my view, it will be hard for legislators to do that because they do not have the information needed to cut out low priority programs, and they will get blamed for budget cuts that are intended to hurt the public.
David Ferguson is a former Director of Arkansas’ Bureau of Legislative Research, having a thirty-two-year career as an attorney for the Arkansas legislature. After retirement from state service his primary focus has been beef cattle farming. He is also a former officer of Conduit for Action.
[i] Davis v. Michigan Dept. of Treasury, 489 U.S. 803 (1989)
[ii] Barker v. Kansas 503 U.S. 594 (1992)
[iii] http://www.arkansasonline.com/news/2016/nov/10/5-48b-state-budget-sought-20161110/
[iv] http://www.arkansasonline.com/news/2016/nov/10/5-48b-state-budget-sought-20161110/
